Why Warren Buffett Just Hit the Eject Button on Consumer Stocks

On Sept. 16, 2009, Warren Buffett declared the Great Recession officially over. But is it still over?

In an interview on CNBC back then, the world's most famous super-investor argued that because the economy had "plateaued at the bottom" and could only go up from there, he was once again buying stocks -- and "getting a lot for [his] money." Obediently, the Dow Jones Industrial Average then proceeded to climb 36% over the next three years.

Unfortunately, times change, economies wane ... and it seems Buffett may have had a change of heart.

Recently, Buffett has complained of disappointing performance at some of the more consumer-oriented holdings of his Berkshire Hathaway (BRK-A) (BRK-B) investment vehicle -- stocks such as Johnson & Johnson (JNJ), Procter & Gamble (PG), and Kraft (KFT). Now, in a regulatory filing dated Aug. 3, Berkshire is reporting about a 21% reduction in the amount of consumer products stocks it holds, even as it ups its exposure to banking, insurance, and industrial stocks.

Crunching the numbers earlier this week, Bloomberg concluded that Buffett appears to be reducing his "bets on consumer-products stocks." If that's what he is in fact doing, then this might bode poorly for an economy that depends on consumer spending for 70% of its growth.

Appearances Can Deceive

But the operative word here is "if": If Buffett thinks a double-dip recession is imminent, and if he's selling consumer stocks to avoid taking a hit, that would be bad news for our economy.

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But what if Buffett has a different reason for selling his stocks? Some folks think that's a more likely explanation.

Buffett biographer Andrew Kilpatrick, for one, thinks Buffett may be preparing to "fire at an elephant" -- a euphemism referring to the megadeals Buffett has favored when spending Berkshire's cash of late. At the Berkshire shareholder meeting in May, Buffett let slip that he'd been eyeing one big potential acquisition valued at roughly $22 billion. That deal ultimately didn't happen -- but maybe Buffett just needed a bigger gun.

It's possible Buffett has been selling off consumer stocks to raise cash for a new big-game hunting expedition. He's certainly got the money for it now. As of its second-quarter report, Berkshire had $40.7 billion in cash and equivalents -- $2.8 billion more than its first quarter.

Whom might he be targeting? Let's assume Berkshire's desired acquisition size is still $22 billion, more or less. U.S. stock exchanges list 78 separate companies valued at $20 billion to $30 billion, putting them squarely in the sights of Buffett's "elephant gun." Here are some of the likely suspects.

• Run for the border: One thing's for sure about Buffett: He's no fitness fanatic. To the contrary, his fondness for cheeseburgers and Cherry Coke is legendary. Now that he has a little extra spending money jingling in his pocket, he might decide to take a look at YUM! Brands (YUM), owner of Taco Bell and KFC.

• Trainspotting for bargains: But I think we can spot a better bargain. We all know how Mr. Buffett loves trains. (What growing boy doesn't?) His purchase of Burlington Northern Santa Fe in 2009 made Berkshire one of the nation's leading railroad operators. Today, for the low price of just $24 billion, he can expand his train set with the acquisition of either Norfolk Southern (NSC) or CSX (CSX). Plus, both stocks sell for P/E ratios of less than 13 -- considerably cheaper than what Buffett paid for BNSF three years ago.

• An insure thing: Still, as much as he loves his trains, Buffett's first love has always been insurance. For this reason, he may be particularly interested in insurer AFLAC (AFL), a relative bargain at just eight times earnings and even more affordable than the railroads -- just $21.4 billion. As an added bonus, AFLAC would fit in nicely with Berkshire's GEICO business.

• A deal that just might fly: Similarly, Buffett could find synergies with a purchase of defense contractor General Dynamics (GD). While suffering from a downturn in demand for armored fighting vehicles, America's biggest tank maker has been sold down to bargain-basement levels -- just nine times earnings. Buffett loves a bargain as much as anyone else. Plus, General Dynamics also makes Gulfstream business jets -- the kind that fly so well for Berkshire's "NetJets" airplane-sharing company.

A $30 billion-plus bank account opens many possibilities for Buffett. Will he spend it all in one place -- perhaps even one of these places? Stay tuned.